50/30/20

So what is the 50/30/20 rule?

The 50/30/20 rule appeared in a book by Sen. Elizabeth Warren, D-Mass., written before she became a legislator. As a Harvard professor specializing in bankruptcy law, Warren knew how easy it is to get into trouble with poor budgeting and extensive debt. Yet rather than espousing a complicated budgeting system that would track every single expense to the penny, Warren chose to include a much simpler approach.

The idea of the rule is to allocate 50% of your after-tax earnings to necessities like food, shelter, clothing, and transportation. 30% of your earnings can be utilized for discretionary spending on things you want but don't absolutely need, such as entertainment, vacations, and eating out.  That leaves the remaining 20% to go toward paying down debt or building up long-term savings. 

Below is a brief summary of the three components of this method, for your information and entertainment.

The 50% part

In the 50/30/20 plan, you calculate how much that you have to spend on needs every month such as mortgage or rent payments, utilities, car payments, insurance, groceries and other necessities. According to the rule, the amount that you spend on these things should comprise no more than 50% of your after-tax pay.

Of course, you must be able to differentiate between expenses that are needs and ones that are actually wants. Any payment that you can skip with only minor inconveniences such as not having cable, or the latest iPhone, or going to a concert with your friends is really more of a want than a need. Any payment that would severely impact your family's quality of life, like not having water or heat, or being unable to get to where they need to go due to lack of transportation, is a need.

Keep in mind that the 50/30/20 rule takes your after-tax pay into consideration, so if you're earning $1,000 per week but only taking home $800 after various government entities take their cut and your insurer and any other automatic deductions, you're really working with $800 per week rather than the full thousand.

The 30% part

With the 50/30/20 rule, you are to limit your wants to 30% of your take-home pay. These are the funds that you could be using to go on those vacations, purchase additional outfits or shoes, the latest iPhone, or whatever it is that floats your boat.  Perhaps even a boat.  

Remember that this 30% part is supposed to cater to your wants, including basic niceties of the life that you enjoy like your unlimited minutes and messaging plan, your Comcast cable bill like the one that I pay even though I hate it, trips out with your friends, and going to see that new movie or dine at a nicer restaurant.

If you're family is like mine, you may often find yourself spending more than 30% on these wants. If you were to go over your bank statements for the last several months or even years, you just might find that you are spending quite a lot in this category. going out for drinks, dining out way more than you really should, subscribing to Netflix, getting that latte every morning instead of brewing your own coffee, going out for lunch several times per week or sometimes even more.  /These, and other things that fit into this category, are the ones that you really should be limiting to 30% of your total expenditures.

I suppose that this applies to me, as well. While I admit to having a book buying and magazine subscribing affliction, I really have not improved upon those two things this entire year. 

As a matter of fact, if I was forced to testify in court or before Congress, for instance in a confirmation hearing to become a Supreme Court Justice 😏 , I would have to estimate that I have probably purchased at least twenty additional books so far this month and last month combined. The number might be even a little higher. Since I purchase them used and at library book sales, it doesn't amount to much spending. But really it is something that I must take a step back from before our bedroom looks like this:

The 20% part

As you undoubtedly already know, this being a personal finance blog in nature, the final 20% of your take-home pay should be used for savings and debt repayments. This is the money that we personal finance folks like to think and write about; the funds that you use to pay down debt like your credit cards, save for a rainy day fund, and plan for your future. This is where this simple 50/30/20 plan helps you the most. Also keep in mind that the 20% is not a hard cap. If you can find a way to save more or to pay off more of your debts or to invest more into your retirement accounts, by all means do it.

For yours truly, I never pass up the chance to repeat my main mantra, which is to Pay Yourself First. In my family's case, I call it Paying Ourselves First because I am the one in our family who handles our finances and makes sure to contribute to my wife's Roth IRA and my own every month, as well as our daughter's 529 plan. As I have written many a time, I automatically send $400 to her Bright Start savings account on the first of every month, and have done so for that amount or higher for the majority of her lifetime.

What I need to improve upon is sending larger payments to my wife's and my IRA, having underfunded them for quite a few years due to focusing on achieving my savings goals for my children's college accounts.

I know that the prevailing wisdom is to fund your own retirement accounts first because you cannot borrow your way through retirement, whereas your children can borrow their way through college. But I, like many other people according to a recent study done by Personal Capital, was and remain determined to save enough money to put my children through their undergraduate college years, just as my own parents did and my wife's parents did so many years ago for her, as inexpensive as it was back then.

I realize of course that the amount of inflation has been massive since that time, my final semester of paying out-of-state tuition at the University of Wisconsin at Madison in 1992 finally reaching the $4,000 mark. These days, that same semester of out-of-state tuition would cost $17,400, or more than 400% inflation over a period of time when the overall economy has experienced less than 200% inflation per the Consumer Price Index:

But as I wrote in my last post, I am enduring 30,000 points of pain and ready to take on a similar amount in three more years when our daughter makes her way to an institution of higher expenses  learning. This was not intended to be a long post about college finance, however, it certainly comes into play when I contemplate trying to allocate 20% of our take-home pay to debt repayment and investing.

I have never and will never claim to be good at budgeting.  You may read a dozen posts about the importance of budgeting, as it does seem to be the most written about topic in the personal finance blogosphere, but the 50/30/20 rule is about as close as I'll ever venture into the topic.  I don't consider myself an anti-budgeter, however I must confess tobeing a non-budgeter.

When it comes to trying to become better at budgeting, I simply cannot think of any better way that I've ever heard so far then Ms Warren's 50/30/20 rule.